Making Sense of Mortgage Lingo
It’s no doubt that purchasing a home can be both exciting and nerve-wracking. Besides being the biggest purchase you’ll probably ever make, the process of securing a mortgage to pay for it brings a whole new vocabulary of terms that can be quite confusing. Let Millbury Savings Bank explain some of the terminology so you can be a more informed borrower.
What is a debt-to-income ratio?
In order to decide how much you can afford, banks need to estimate how much of your monthly income is available for a mortgage payment. They do so by determining and then using your debt-to-income ratio as a guideline.
Generally, the debt-to-income ratio is expressed as two numbers. The first number indicates the maximum percentage of your income available for housing expenses, such as principal, interest, property taxes, and homeowner’s insurance. The second number indicates the maximum percentage of your income available for these housing expenses plus all other recurring debt (e.g., auto and student loan payments, credit card payments, etc.). Ratios are typically 28/33, except for first time homebuyers where ratios may be higher. These limits can vary from lender to lender, however.
What is escrow?
An escrow account is an account set up with your lender, into which you pay an amount over and above your loan’s principal and interest payment. The extra money is then used to cover such expenses as homeowner’s insurance and property taxes. If you have an escrow account, you typically submit these bills when received to your bank to be paid out of your escrow account, instead of paying them directly yourself.
What is a point?
A point is simply one percent of your mortgage loan amount. So, for example, one point on a $100,000 loan is $1,000. Paying points typically “buys down,” or lowers your interest rate, and would be added to your closing costs. Our recommendation: Only consider paying points if you’re planning to stay in the house long enough so that the interest savings exceeds the amount you’d pay in points.
What are closing costs?
Closing costs are all of the one-time fees and charges associated with buying your home and securing your mortgage. They typically include everything from appraisal fees, title searches, recording fees, and bank attorney fees, among others.
But keep in mind that you’ll also need to cover other costs at closing, called "prepaid items." These involve paying a certain number of months of property taxes and homeowner’s insurance in advance.
What is PMI?
Private mortgage insurance, or PMI, is simply extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home’s value —in other words, buyers with less than a 20 percent down payment. PMI’s purpose is to protect a lender against loss if a borrower defaults on a loan.
PMI plays an important role in the mortgage industry by enabling borrowers with less cash to have greater access to homeownership. With this type of insurance, it is possible for you to buy a home with as little as a 3 percent down payment, depending on the loan program. This means that you can buy a home sooner without waiting years to accumulate a large down payment.
What is an APR?
The annual percentage rate or APR is a measure of the total cost of your mortgage, including some of the closing costs, points, and other fees and charges, expressed as a yearly interest rate. The APR is actually an artificial measurement, developed to help borrowers compare loans from different lenders. While it doesn’t have any bearing on the actual rate of interest you will pay on a particular loan, your interest rate is part of the rather complex mathematical formula used to derive the APR.
What is a rate lock?
Usually, banks guarantee a specific interest rate only for a specific period of time and at a specific cost. That period of time, normally 30, 60, or 90 days, is known as the rate lock period. Generally, it makes sense to lock in a rate only when you’re sure you can close within the specified time period.
What is “pre-approved” versus “pre-qualified”?
When you’re pre-qualified, the bank gives you a rough estimate of how big a loan you might qualify for, taking into account the information you provide on your debt, income, and savings. On the other hand, with preapproval you actually complete a mortgage application, which is underwritten by the lender. Pre-approval reflects a specific loan amount, taking into account the interest rate, principal, interest, taxes, and insurance you’ll likely pay.
Pre-approval is a far more involved process than pre-qualification, because more of your financial data and documents are examined to establish a firmer number. When buying a home, preapproval is more meaningful to the seller and therefore typically puts your offer to purchase on much firmer ground than pre-qualification.